2023-06-22 12:49:28 ET
Summary
- Tyson Foods' stock price has dropped recently, providing a buying opportunity for investors due to the company's focus on meat products and expansion into meat substitutes.
- Despite facing headwinds such as inflation and environmental concerns, Tyson Foods is working to improve efficiency and reduce costs, with management initiatives expected to improve long-term operating margins.
- The meat market is still growing strong, with a CAGR of 7.5% expected through 2027, and Tyson Foods is well-positioned to capitalize on this growth.
Introduction
Tyson Foods ( TSN ) is a meat processing company in the United States that sells its products to restaurant chains, grocery stores and convenience stores.
The stock is up significantly over the past 10 years, slightly less than the S&P500, but the stock price has higher volatility. The recent drop in the share price provides a strong buying opportunity for investors looking to buy the stock cheaply.
Tyson Foods faces difficult challenges regarding animal welfare and its environmental impact. The company reacted and introduced several sustainable beef products which also reduces GHG emissions by 10%. They are acting fast and there is clearly a noticeable improvement. However, with the acquisition of the Williams Sausage Company, Tyson Foods remains a strong player in the meat business.
The meat market is still growing strongly and Tyson also differentiates itself by offering meat substitute products. With its cheap valuation, investors could buy shares at a sharp discount. Tyson Foods is therefore worth buying.
Meat Market Size Is Still Growing Strong
Recently there was a strong presence in meat substitutes, but that craze is now over. Beyond Meat ( BYND ) is a major player in meat substitutes that also offers several burgers in McDonald's (MCD). Many people tried their products, but now Beyond Meat's sales are declining. This could indicate that meat substitutes are not yet the new normal.
Tyson Foods focuses mainly on meat products but has expanded its product line to include meat substitutes.
The meat market is still growing strong, and Statista expects that the meat market will grow at a CAGR of about 7.5% through 2027. Growth catalysts are price increases but also population growth. The most sought-after meat product is poultry meat because it has higher protein and lower fat content.
The COVID-19 pandemic caused intense growth in meat substitutes because of increasing consumer health awareness. Some consumers are switching to meat substitutes as they become increasingly aware of environmental and animal welfare impacts.
Yet for Tyson Foods, I do not yet see a worrisome trend in meat volumes. Even with the introduction of meat substitutes, Tyson Foods will be well positioned in the growing meat market.
Meat Market Worldwide (Statista)
Significant Headwinds
The second quarter was very weak mainly due to a sharp reduction in full-year 2023 earnings estimates, resulting in a sharp negative rebound in the share price. Revenue remained flat in the second quarter of 2023 compared to the same quarter a year earlier. But adjusted operating income fell sharply due to a negative price/mix and higher cost of goods sold.
Sales, AOI, and EPS performance (TSN second quarterly earnings presentation)
Tyson Foods derives the largest sales from their beef products, accounting for about 35% of sales. However, in the past six months, sales of beef products were down 6.9% from last year. This was due to both lower volumes and lower prices. While in 1H22 adjusted operating margins were the strongest at 15.9%, this year they have fallen sharply to just 1.5%. Inflation has dramatically affected their costs. Prepared Foods were the most profitable in this half year with an adjusted operating margin of 10.4%.
Chicken segment sales continue to perform well, with sales up 9% over the same period to $8.69 billion. This was due to both higher volumes and prices. Still, Tyson Foods needs to focus on this segment due to higher input costs, higher feed ingredient costs of $145 million and an unfavorable year-over-year impact of derivatives of approximately $135 million. As a result, adjusted operating income from the chicken segment came to a loss of $166 million last quarter.
The pork segment will be supplemented by the acquisition of the Williams Sausage Company. Last quarter, volumes increased 1.1%, but the average price dropped significantly by 10.3%. Sales volume increased due to better pork availability, but the average selling price decreased due to weak global demand. This affected the profitability of this segment. In 1H22 adjusted operating profit was still good at 7%, but in the same period this year adjusted operating profit came to a loss.
What is concerning is that Tyson Foods lowered its full-year 2023 expectations from those of the first quarter. Revenue growth remains unchanged, but adjusted operating margin for the chicken, beef, and pork segment has been significantly reduced. Higher interest rates also caused a $10 million increase in net interest expense from the first-quarter estimate.
Lower sales and margin expectations (TSN second quarterly earnings presentation)
Macroeconomic conditions remain challenging, also raw material prices for fresh chicken meat are much lower than last year. Boneless breast meat, tenders, and wings were down by more than 50%.
Tyson Foods management reduced its finished goods inventory by nearly 20% during the quarter. They also decided to close a less productive chicken plant. This is a positive development to increase the company's efficiency and reduce costs.
CEO Donnie King talks about the improvements in their plants:
We increased our internal production, gaining 130 basis points of harvest share compared to last year. This led to pound share gains of 250 basis points in value-added retail and 60 basis points in food service. As you can see, we are well positioned to keep growing. We continue to invest in automation and digital capabilities, with opportunities to improve our yield. We now have 50 debone lines that are fully automated. We have room to optimize our cost structure and a portion of the actions we took last month are focused on this.
Importantly, we are working more closely than ever with our customers to create value jointly. We're building long-term supply partnerships that have clear benefits for both sides. We improved order fill rates by more than 20%. This was no accident, and I'm proud of our team for accomplishing this. We're winning in the marketplace by winning with our customers.
Tyson Foods is clearly in an environment with many headwinds, but fortunately these headwinds are temporary in nature. A good example is inflation, which is already down sharply from last year. As a result, the sharp increase in purchase prices is being better controlled, making Tyson Foods' long-term operating margins attractive again. Price increases in the current quarter are another good example. Tyson Foods' product prices lag the market. Therefore, the effect of price increases will not be noticeable until the third quarter. Management's initiatives are also contributing to an improved profit margin. Tyson Foods is well on its way to becoming a more efficient company.
Dividends and Share Repurchases
Despite the challenging outlook, Tyson Foods pays a good dividend. About 25% of free cash flow is paid out as dividends. Despite greatly reduced free cash flow in 2022, I expect Tyson Foods to maintain its dividend and do not expect a dividend cut. I expect the headwinds to be temporary and profitability to return when inflation reaches normal levels.
Tyson Foods' dividend growth history (TSN ticker page on Seeking Alpha)
A look at the cash flow statements shows that dividends have risen sharply in recent years. In addition to distributing dividends, Tyson also repurchases shares and the buyback yield was high at 3% in 2022. Buybacks increase the dividends per share but also increase the earnings per share. At the same price level, the P/E ratio becomes then more favorable.
Cash flow highlights (TSN's annual report and calculations)
Favorable Valuation And Good Outlook
The share price has fallen significantly from its high of $100 to $50 currently, which makes the valuation metrics favorable.
Although EBIT has declined significantly due to temporary headwinds, I expect EBIT to return to normal levels in the near future. However, management does not give us EBIT guidance, so I find it difficult to compare the valuation to the enterprise value versus EBIT chart.
There are several other valuation metrics to get insight into the stock valuation. First, I prefer the enterprise value/revenues ratio which includes cash and debt in the valuation.
What we see is that the enterprise value/revenues ratio is trending downward and below the 3-year average of 0.77. The ratio currently stands at 0.5, which is 35% cheaper than the average. Tyson Foods had a more attractive valuation in 2015 than it has today. Back then, the enterprise value/revenues ratio was just 0.3. Tyson Foods has become more profitable over the years; its operating margin in 2022 was much higher than in 2015. Thus, a higher enterprise value/revenues ratio is a logical consequence.
The P/E ratio does not take into account cash and debt into the valuation, but it is a ratio that is well followed by many analysts. This also gives us insight into the near future.
We distinguish between the GAAP and non-GAAP P/E ratio. YCharts can only display the GAAP P/E ratio which is currently 12. The P/E ratio has risen sharply due to lagging earnings this half-year.
Looking at the near future, 9 analysts revised their expectations downward. These analysts expect a sharp decline in non-GAAP earnings per share for 2023, but from then on it will rise again. Input costs will be more manageable as inflation returns to desirable levels. Adjusted operating margins will increase as a result.
Tyson Food's earnings estimates (TSN ticker page on Seeking Alpha)
Still, there are risks because consumers may prefer meat substitutes. I think this trend will only slowly blossom as the meat market continues to grow strongly. Once the challenges are over, I expect the stock to rebound to higher levels, but in the long term, investors should be mindful of the potential risks of changing market sentiment.
Conclusion
The meat market remains a lucrative one that continues to grow strongly despite the potential risks of meat substitutes. The meat market remains strong and chicken products are particularly popular. The chicken segment performed particularly strongly with sales up 9% compared to the same period last year.
Tyson Foods is a large meat company specializing in chicken, beef, pork and other meat products, but it also differentiates its product portfolio by offering meat substitutes in addition to its extensive range of meat products.
In the second quarter, the operating margin declined sharply due to higher input costs and an unfavorable impact of derivatives. The focus is now on significant cost savings and increasing the operating margin and the management is well on its way to achieving this. Also, the inflation is decreasing, making input costs more manageable. These are good prospects for the coming periods. However, 2023 will be challenging, and Tyson Foods has lowered expectations for fiscal year 2023. I see these challenges as temporary and the stock's valuation has already become very attractive. In my view, Tyson Foods' is a buy because of its attractive valuation, management's initiatives to make the company more efficient, and because input costs are more manageable.
For further details see:
Tyson Foods: Cheap Entry Point, Meat Market Still Growing